Gazprom: Gas Giant Under Strain Nadejda Makarova Victor Working Paper #71 January 2008 The Program on Energy and Sustainable Development at Stanford University is an interdisciplinary research program focused on the economic and environmental consequences of global energy consumption. Its studies examine the development of global natural gas markets, the role of national oil companies, reform of electric power markets, international climate policy, and how the availability of modern energy services, such as electricity, can affect the process of economic growth in the world’s poorest regions. The Program, established in September 2001, includes a global network of scholars—based at centers of excellence on five continents—in law, political science, economics and engineering. It is based at the Freeman Spogli Institute for International Studies. Program on Energy and Sustainable Development Freeman Spogli Institute for International Studies Encina Hall East, Room E415 Stanford University Stanford, CA 94305-6055 http://pesd.stanford.edu About the National Oil Company Study While the role of the state is declining in nearly every sector of world economic activity, in hydrocarbons the pattern is quite different. State-controlled oil companies—so-called national oil companies (NOCs)— remain firmly in control over the vast majority of the world's hydrocarbon resources. Some NOCs are singular in their control over their home market; others engage in various joint ventures or are exposed to competition. PESD’s study on National Oil Companies focuses on fifteen NOCs: Saudi Aramco, NIOC (National Iranian Oil Co), KPC (Kuwait Petroleum Co), PDVSA (Petróleos de Venezuela) , ADNOC (Abu Dhabi National Oil Company), NNPC (Nigerian National Petroleum Co), PEMEX, Gazprom , Sonatrach, CNPC, Petrobras, Petronas, ONGC, Sonangol, and Statoil. These enterprises differ markedly in the ways they are governed and the tightness of their relationship with government. NOCs also vary in their geological gifts, as some are endowed with prodigious quantities of "easy" oil while others must work harder and apply highly advanced technologies; some have sought gas, which requires different skills and market orientation than oil, while others stay focused on liquids. These case studies explore whether and how these and other factors actually explain the wide variation in the performance of NOCs. About the Author Nadejda Makarova Victor is a Research Fellow at the Program on Energy and Sustainable Development at Stanford University. Her current research efforts focus on the performance of national oil companies, the political and economic implications of the shift to natural gas, and the role of Russia in world oil and gas markets. In addition, Dr. Victor is involved with the International Atomic Energy Agency (IAEA) study on Energy and Sustainable Development evaluation. She is also consulting at IIASA, where she focuses on economic development indicators and the long-lasting debate over SRES emissions scenarios. Previously, Dr. Victor was a Research Associate in the Economics Department at Yale University under Prof. William Nordhaus, where she developed a new spatially referenced economic database. At the same time she was involved in research at the Program for the Human Environment at Rockefeller University. There she analyzed the technical changes bearing on the environment, rates and patterns of technical change in the information and computer industries, and R&D in the energy sector. Before she moved to the US in 1998, Dr. Victor was a Research Scholar at the International Institute for Applied Systems Analysis (IIASA) in Laxenburg, Austria. Her IIASA research included analysis of the long-term development of economic & energy systems, energy modeling at regional and global scales, scenarios of infrastructure financing, trade in energy carriers and environmental impacts. She had extensive collaboration with international organizations, including the World Energy Council (WEC) and the Intergovernmental Panel on Climate Change (IPCC). She holds a Ph.D. and a B.A. in Economics from Moscow State University. TABLE OF CONTENTS Introduction Summary Section 1 Russian Gas and Oil: Capabilities and Limits 1.1 History of Gas in Russia 1.2 Overview of the Russian Gas Sector 1.3 Overview of the Russian Oil Sector 1.4 Oil and Gas in the Russian Economy Section 2 Gazprom: Profile of the Largest Company in Russia 2.1 International Reach 2.2 Corporate Holdings 2.3 Corporate Structure 2.4 Reserves, Exploration and Production 2.5 Transportation and Storage Infrastructure 2.6 Non-Core Activities 2.7 Capitalization 2.8 Finance 2.9 Business Strategy 2.10 Gazprom’s Investment Strategy and Requirements Section 3 Yin and Yang: Relationship between the State and Gazprom 3.1 Privatization of the Oil and Gas Sector in Russia 3.2 PetroKremlin: Re-Nationalization of the Oil and Gas Sectors 3.3 Russia’s Oil and Gas Sector Tax System 3.4 Production Sharing Agreements (PSA) in Russia 3.5 The New Subsoil Law Conclusion References Appendix 1 – Early History of the Russian Oil and Gas Sectors Appendix 2 – List of Major Companies with Gazprom Shareholders Appendix 3 – Gazprom’s Major Joint Ventures and Overseas Subsidiaries Appendix 4 – Gazprom’s Production, Supply and Financial Indicators in 2001-2004 Appendix 5 – Gazprom’s Financial and Product Flows in 2005 Gazprom: Gas Giant Under Strain Nadejda Makarova Victor Introduction This study, which is part of a larger research project on state-controlled hydrocarbon resources, looks at the strategy, evolution and performance of Gazprom, Russia’s largest state company. It explores the critical role that Gazprom plays in the Russian economy, as well as its growing and evolving role as an instrument of state. Section 1 provides an overview of the Russian oil and gas sectors, with special attention to the history of gas as a Soviet ministry—the period when nearly all of Gazprom’s legacy assets in gas fields and pipelines were developed. Section II focuses on Gazprom as an organization, including its structure, revenues, and its activities within Russia, Western Europe and overseas. As the study makes clear, Gazprom is far more than the world’s largest gas company. It is a monopoly controlled by the Kremlin, serving both economic and political agendas, as well as a multidimensional investment enterprise seeking a larger role on the world stage. Section III looks at the “yin and yang” of Gazprom and the state, and the reasons for early privatization efforts following the demise of the Soviet Union, as well as the current “re-nationalization” of the oil and gas sectors as world prices have risen. Summary Russia holds the world’s largest reserves of natural gas. It alone produces 22% of the world’s gas, and in recent years has become the world’s top gas exporter, mainly to Europe. In addition to the rich endowment of gas, Russia holds the sixth-largest oil reserves in the world, and now stands as the world’s second-largest oil producer. The Russian state has followed strikingly different paths in the oil and gas industries since the breakup of the Soviet Union. In the case of oil, Russia largely privatized all exploration and production activities, while keeping the pipeline infrastructure under state control for exporting oil. The privatization of oil production raised badly needed cash at a time when the Russian state budget faced particularly hard times. Privatization also allowed favors for individuals and enterprises that were at the time politically well connected to the Kremlin. 5 With gas, the Russian government followed a different strategy. It retained the largest stake in the Russian gas behemoth, Gazprom, and has been able to run the enterprise as a state-controlled firm. Only when it was confident that the enterprise was under unequivocal control of the Kremlin was the Russian government willing to sell larger stakes—while retaining a controlling share—to private investors and favored companies in the west. Over the last five years the Kremlin has also sought to assert greater control over the oil industry, partly by building within Gazprom a large oil company. The result is that Gazprom is now Russia’s most important “national energy champion,” with enormous political clout, both at home and abroad. By market capitalization and any reasonable valuation of its assets, Gazprom is the richest company in Russia. In 2005 Gazprom alone accounted for 8% of Russia's GDP, and provided about 25% of its earnings to the federal budget. Even before the new company acquisitions of 2005 and 2006, Gazprom had become the largest gas company in the world. It supplies most of the gas used by households and industry in Russia, as well as gas that generates around 50% of Russia’s electricity. Gazprom makes the largest portion of its revenues by exporting gas to Europe, for which it charges oil-linked world prices, which are roughly five times the prices paid by Russian consumers. If Gazprom optimized performance it would focus on export markets and on markets where it could charge similarly high prices. Indeed, it has done that in places where, politically, it could get away with that strategy—namely, by expanding the volume of export contracts to Europe and by raising the price of gas that it sells to the near-abroad in Ukraine, Belarus, Moldova and Georgia. It is the home market, however, which is the key to Gazprom’s political leverage. By tacit agreement with the state, it provides extraordinarily cheap gas to render support to a highly inefficient economy whose customers have yet to install meters. Gazprom is stuck between its largest market in terms of volume (Russia), for which it actually loses money, and its largest market in value (Europe today, but possibly China in the distant future). The firm and the Kremlin have tried to bring the cost of domestically supplied gas into line—which would realign Gazprom’s economic incentives and also help forestall a gas crisis by inducing much more efficient use of gas in Russia—but that has been politically difficult.